The Fed made history with a rate rise and the world didn’t collapse. What’s next for the greenback?
The team at Bank of America Merrill Lynch gives us the bottom line:
Here is their view, courtesy of eFXnews:
The USD’s experience of strengthening the 3-6 months into the first Fed hike, only to selloff in the months after, leaves us hesitant to read today’s Statement and Press conference as unencumbered bullish USD factor. More specifically, net USD long positioning was still quite high heading into the meeting, therefore, the USD’s retracement was likely a reflection of position adjustment than a fundamental catalyst.
Dollar performance going forward (now that the Fed has started the normalization process) will depend on: First, US data and the pace of hikes—if the Fed is able to hike 4 times next year versus the 2 priced into the market, the USD will move higher in our view, particularly against a backdrop of further policy easing by the ECB and BOJ in 2016. A sharp RMB depreciation could slow the pace of USD appreciation, in our view.
And second, equity performance which, in part, will reflect the market’s assessment of the ability of the economy to handle higher rates (and a higher USD). Given the USD’s positive correlation with equities, any weakness here will likely hamper USD gains against funding currencies like the EUR and JPY in this scenario. Recent financial market volatility and the Fed’s still consistent message 0f conducting 4 hikes in 2016 (vs only 2 priced by the market) make us cautious on this front.
Bottom line: Today’s statement and press conference failed to meet the market’s hurdle for a dovish hike. Going forward we continue to see the USD rallying over the course of 2016, but the near-term outlook is clouded by positioning, and the ability of US data to sustain a need for a greater number of hikes than the market prices.
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